Final Regulations on IRC §199A Deduction, As Well As the Calculation of Wages

         I.            The deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the taxpayer’s QBI subject to the W-2 wage limit) plus

       II.            20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year. As per IRC §199A(c)(2)

QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer, as per IRC §199A(c)(1). For this purpose, qualified items of income, gain, deduction, and loss are items of income, gain, deduction, and loss to the extent these items are effectively connected with the conduct of a trade or business within the U.S. under IRC §864(c) and included or allowed in determining taxable income for the year. If the net amount of qualified income, gain, deduction, and loss relating to qualified trade or businesses of the taxpayer for any tax year is less than zero, the amount is treated as a loss from a qualified trade or business in the succeeding tax year.

The deduction cannot exceed the greater of:

• 50% of the W-2 wages with respect to the qualified trade or business (“W-2 wage limit”), or
• the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.”

Qualified property is defined in IRC §199A(b)(6) as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

The above limit does not apply for taxpayers with taxable income below the “threshold amount” ($315,000 for married individuals filing jointly, $157,500 for other individuals, indexed for inflation after 2018). The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly ($50,000 for other individuals). (IRC §199A(b)(3)) Thus, for 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and other individuals with taxable income over $207,500.

For a partnership or S corporation, each partner or shareholder is treated as having paid W-2 wages for the tax year in an amount equal to his or her allocable share of the W-2 wages paid by the entity for the tax year. A partner’s or shareholder’s allocable share of W-2 wages is determined.

The final regs adopt many of the rules described in the proposed regs, with certain revisions in response to comments. Clarifying language and additional examples have been added throughout the final regs.

The final regs also determine when to treat two or more trusts as a single trust for purposes of subchapter J of chapter 1 of subtitle A of the Code (subchapter J). The final regs are not intended to address IRC §643 in general.

The discussion of the regs in the Treasury Decision is broken down as follows: Part I provides an overview of the Code provisions addressed by the final regs. Part II discusses the operational rules, including definitions, computational rules, special rules, and reporting requirements. Part III addresses the determination of W-2 wages and unadjusted basis immediately after acquisition (UBIA) of qualified property. Part IV discusses the determination of qualified business income (QBI), qualified real estate investment trust (REIT) dividends, and qualified publicly traded partnership (PTP) income. Part V addresses the optional aggregation of trades or businesses. Part VI discusses specified services trades or businesses (SSTBs) and the trade or business of being an employee. Part VII addresses the rules for relevant passthrough entities (RPEs), PTPs, beneficiaries, trusts, and estates. Part VIII discusses the treatment of multiple trusts.

Rev Proc 2019-11 goes on to discuss the calculation of qualified wages, as it pertains to the Code Section.

The revenue procedure provides three methods for calculating W-2 wages for purposes of IRC §199A(b) and the regs thereunder.

How the results of these methods are to be used. W-2 wages calculated under the revenue procedure are not necessarily the W-2 wages that are properly allocable to QBI and eligible for use in computing the IRC §199A limitations. After computing W-2 wages under the revenue procedure, the taxpayer must determine the extent to which the W-2 wages are properly allocable to QBI. Then, the properly allocable W-2 wages amount is used in determining the W-2 wages limitation under IRC §199A(b)(2) for that trade or business as well as any reduction for income received from cooperatives under IRC §199A(b)(7).

The discussions of “wages” in the revenue procedure and in the regs under IRC §199A are for purposes of IRC §199A only and have no application in determining whether amounts are wages under IRC §3121(a) for purposes of the Federal Insurance Contributions Act (FICA), under IRC §3306(b) for purposes of the Federal Unemployment Tax Act (FUTA), or under IRC §3401(a) for purposes of the Collection of Income Tax at Source on Wages (federal income tax withholding), or any other wage-related determination.

Under the 2018 Forms W-2, the elective deferrals under Code Sec. 402(g)(3) and the amounts deferred under Code Sec. 457 directly correlate to coded items reported in Box 12 on Form W-2. Box 12, Code D is for elective deferrals to a Code Sec. 401(k) cash or deferred arrangement plan (including a SIMPLE 401(k) arrangement); Box 12, Code E is for elective deferrals under a Code Sec. 403(b) salary reduction agreement; Box 12, Code F is for elective deferrals under a Code Sec. 408(k)(6) salary reduction Simplified Employee Pension (SEP); Box 12, Code G is for elective deferrals and employer contributions (including nonelective deferrals) to any governmental or nongovernmental Code Sec. 457(b) deferred compensation plan; Box 12, Code S is for employee salary reduction contributions under a Code Sec. 408(p) SIMPLE (simple retirement account); Box 12, Code AA is for designated Roth contributions (as defined in Code Sec. 402A) under a Code Sec. 401(k) plan; and Box 12, Code BB is for designated Roth contributions (as defined in Code Sec. 402A) under a Code Sec. 403(b) salary reduction agreement; Box 12, Code F is for elective deferrals under a Code Sec. 408(k)(6) salary reduction Simplified Employee Pension (SEP); Box 12, Code G is for elective deferrals and employer contributions (including nonelective deferrals) to any governmental or nongovernmental Code Sec. 457(b) deferred compensation plan; Box 12, Code S is for employee salary reduction contributions under a Code Sec. 408(p) SIMPLE (simple retirement account); Box 12, Code AA is for designated Roth contributions (as defined in Code Sec. 402A) under a Code Sec. 401(k) plan; and Box 12, Code BB is for designated Roth contributions (as defined in Code Sec. 402A) under a Code Sec. 403(b) salary reduction agreement. However, designated Roth contributions are also reported in Box 1, Wages, tips, other compensation and are subject to income tax withholding.

The three methods. Under the unmodified box method, W-2 wages are calculated by taking, without modification, the lesser of:

1. The total entries in Box 1 of all Forms W-2 filed with SSA by the taxpayer with respect to employees of the taxpayer for employment by the taxpayer; or
2. The total entries in Box 5 of all Forms W-2 filed with SSA by the taxpayer with respect to employees of the taxpayer for employment by the taxpayer.

Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box 1 of Forms W-2 filed with respect to employees of the taxpayer. W-2 wages under this method are calculated as follows:

• Total the amounts in Box 1 of all Forms W-2 filed with SSA by the taxpayer with respect to employees of the taxpayer for employment by the taxpayer;
• Subtract from the total in paragraph (A) of this section amounts included in Box 1 of Forms W-2 that are not wages for Federal income tax withholding purposes, including amounts that are treated as wages for purposes of income tax withholding under Code Sec. 3402(o) (for example, supplemental unemployment compensation benefits within the meaning of Rev Rul 90-72); and
• Add to the amount obtained after paragraph (B) of this section the total of the amounts that are reported in Box 12 of Forms W-2 with respect to employees of the taxpayer for employment by the taxpayer and that are properly coded D, E, F, G, and S.

Under the tracking wages method, the taxpayer actually tracks total wages subject to federal income tax withholding and makes appropriate modifications. W-2 wages under this method are calculated as follows:

• Total the amounts of wages subject to federal income tax withholding that are paid to employees of the taxpayer for employment by the taxpayer and that are reported on Forms W-2 filed with SSA by the taxpayer for the calendar year; plus
• The total of the amounts that are reported in Box 12 of Forms W-2 with respect to employees of the taxpayer for employment by the taxpayer and that are properly coded D, E, F, G, and S.

The revenue procedure also contains rules for taxpayers with a short tax year.